Multi-sector companies’ prospects are highly correlated with healthy operating conditions of the end markets they operate in — like the oil & gas, industrial, aerospace and many others. Few prevailing headwinds are raising demand for air travel globally, improving operations in oil and gas industry, demand from the defense and governmental front as well as technological upgrade in manufacturing processes.

Also, healthy domestic and global economies create a favorable environment for these multi-sector stocks. Global economic growth is projected to be 3.9% in 2018 compared with 3.7% in 2017, with the improvement likely to propel many advanced and emerging nations and various end markets worldwide.

For the United States, growth rate of the economy is predicted to be 2.9% for 2018 compared with 2.3% in 2017 while emerging nations, collectively, are anticipated to grow 4.9% in 2018 compared with 4.7% in the prior year.

For multi-sector companies in the United States, investors’ confidence seems to have strengthened lately, underpinning bright growth potential in the near term. Healthy economic growth is complemented by a favorable labor market, changes in tax policies, growth in the manufacturing sector and governmental development plans. However, trade disputes between the United States and foreign nations, arising out of tariff imposition on number of items have, to some extent, inflated raw material costs and put pressure on corporate margins.

Industry’s Near-Term Returns Slightly Better Than the S&P 500

Looking at shareholder returns over the past month, it appears that the industry and the S&P 500 have roughly followed the same pattern. Strengthening economic conditions, favorable impacts of changes in tax policies and impressive results by many conglomerates have boosted investor confidence in the industry. The industry reached an all-time high of 6.9% on Jul 31.

The Zacks Diversified Operations Industry, a 19-stock group, is the only industry within the broader Zacks Conglomerates Sector. The industry, in the past one month, has yielded 4.6% return, modestly above the gain of 4.4% by the S&P 500.

                                        One-Month Price Performance

Diversified Operations Stocks Trading Cheap

The industry’s valuation is really cheap now. One might get a good sense of the industry’s relative valuation by looking at its price (P) to earnings (E) ratio. This metric is a suitable multiple for valuing companies within Diversified Operations industry. This clearly shows that how much an investor is willing to pay for every dollar earnings of a stock.

The industry currently has a trailing 12-month P/E multiple of 18.79, lower than 19.55 of the S&P 500 over the past month. Cheap valuation along with the company’s healthy price performance in the past month makes the industry an attractive investment destination.

Also, the valuation over a wider timeframe underpins the industry’s current cheap valuation. The current multiple of 18.79 when compared with the highest level of 19.97 since the beginning of the year shows that there is plenty of upside potential left. Moreover, the industry seems inexpensive when compared with the market at large, as the high and median multiples for the S&P 500 are 21.97 and 19.73, respectively.

                                              Price-to-Earnings Ratio (TTM)

Earnings Outlook Improving Gradually

Efforts to keep pace with the rising demand for technologically advanced products are prompting companies to invest in innovative projects. New products in the market will help in tapping demand from the existing customer base as well as attract new customers. This, along with sound economic health of the nation should drive the top line for multi-sector companies, going forward.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The earlier valuation discussion shows that market participants might be interested in gaining exposure in the stock at current levels.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

              Price and Consensus: Zacks Diversified Operations industry

The Price and Consensus Chart (as given above) is not depicting a promising earnings growth potential for the industry. It’s clearly visible that earnings expectations for 2018 and 2019 have lost momentum over time. However, stability from December 2017 is a relief, which becomes clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $2.56 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Diversified Operations industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $2.56 'per share' of the industry for 2018, but how this dollar number has evolved recently.

                                   Current Year EPS Estimate Revisions

As you can see here, the $2.56 'EPS' estimate for 2018 is up from $2.54 at the end of June 2018 and $2.55 at the end of November 2017. In other words, it seems that the analysts are now gaining confidence in the industry’s earnings potential.

Zacks Industry Rank Indicates Solid Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks Diversified Operations industry currently carries a Zacks Industry Rank #92, which places it at the top 36% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank has improved remarkably in the last two weeks. Also, the industry has remained in the top half of the rank list for the majority of the period in the past eight weeks.

Diversified Operations Industry’s Long-Term Growth Prospects Weak

The long-term (3-5) EPS growth estimates for the Zacks Diversified Operations industry appear unattractive.

The group’s mean estimate of long-term EPS growth rate dipped sharply in January 2018, while modest improvement has been witnessed thereafter. Also, the industry’s mean estimate of long-term EPS growth rate of 6.7% is below 9.8% growth rate for the broader Zacks S&P 500 composite.

                              Mean Estimate of Long-Term EPS Growth Rate

The basis of the industry’s long-term EPS growth could be the sharp decline in top line that the companies with diversified operations have been showing since the beginning of 2009.

Bottom Line

The Diversified Operations industry seems poised to deliver respectable returns in the near term. Though prevalent headwinds might create problems, the industry seems prepared to handle such hurdles.

Strong near-term prospects and cheap valuation make this industry a lucrative option for investors seeking exposure in the U.S. conglomerates space. Investing in companies with solid earnings potential and favorable Zacks Rank #1 (Strong Buy) or 2 (Buy) can be good investment strategy.

Stocks to Bet on

Hitachi Ltd. (HTHIY): Shares of this Tokyo, Japan-based company have gained 1.9% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 2.9% upward over the past 30 days. The stock currently sports a Zacks Rank #1. You can see  the complete list of today’s Zacks #1 Rank stocks here.

                                    Price and Consensus: HTHIY

Carlisle Companies Incorporated (CSL): Shares of this Scottsdale, AZ-based company have gained 25.7% over the past year. The Zacks Consensus Estimate for the current-year EPS has been revised 3.4% upward over the past 60 days. The stock currently carries a Zacks Rank #2.

                                Price and Consensus: CSL

Crane Co. (CR): Shares of this Stamford, CT-based company have yielded 16.9% over the past year. The Zacks Consensus Estimate for current-year EPS has been revised 2.3% upward over the past 60 days. The stock currently carries a Zacks Rank #2.

                                     Price and Consensus: CR

Honeywell International Inc. (HON): Shares of this Morris Township, New Jersey-based company have gained 11.4% over the past year. The Zacks Consensus Estimate for current-year EPS has been revised 1.5% upward over the past 60 days. The stock currently carries a Zacks Rank #2.

                                      Price and Consensus: HON